Stock market shrugs off CPI rise but inflation obsession may linger

U.S. stocks gained on Wednesday, shrugging off an initial sharp dip in premarket trading immediately after the release of U.S. government data that showed consumer prices rose more than expected in January.

The Labor Department said its Consumer Price Index increased 0.5 percent last month. That was higher than estimates for a 0.3 percent increase and the 0.2 percent in December. The year-on-year increase in the CPI was unchanged at 2.1 percent.

At first blush, the move higher in stocks seemed counterintuitive. Investors had braced for Wednesday's Consumer Price Index data since concerns about firming inflation were blamed in part for the 10-percent pullback in the stock market from its Jan. 26 record high.

But investors pointed to several reasons why stocks were higher, with the S&P 500 up 0.8 percent in early afternoon trading.

For one, despite the higher-than-expected reading, annual inflation did not cause particular alarm. The "core" CPI, excluding the volatile food and energy components, rose 0.3 percent, the largest increase since January 2017. Still, the year-on-year rise in the core CPI was unchanged at 1.8 percent in January.

In addition, while bond yields rose after the inflation data, the rates did not spike to levels that would be more worrisome for equities.

Of itself, inflation, particularly driven by higher demand, is not necessarily negative for equities," said Rick Meckler, president of LibertyView Capital Management in Jersey City, New Jersey.

Rather, Meckler said, the concern is if bond rates adjust substantially higher in response to inflation data. Such increases in bond rates would provide more investment competition to stocks, after years of low yields made equities comparatively more desirable.

On Wednesday, while yields climbed, the benchmark 10-year Treasury note had not yet risen significantly above 2.90 in yield, a level that was closely watched.

"Maybe if we saw the yield continue to rise, if it went up past 2.90, it might hit stocks," said Michael Antonelli, managing director for institutional sales trading at Robert W. Baird in Milwaukee. "That its stabilized has helped."

The Federal Reserve, whose mandate includes price stability, has a 2-percent inflation target. But the U.S. Central Bank tracks the different personal consumption expenditures (PCE) price indexes, which has consistently undershot the Fed's target.

Inflation has to be put into context," said Joseph LaVorgna, chief economist for the Americas at Natixis in New York. "The year-over-year rate on the core is still below 2 percent. The core PCE, which the Fed thinks is better, is even lower, well below 2 percent."

Even as the stock market shrugged off Wednesday's data, the focus on inflation may linger. Equity investors will look to the monthly CPI data much in the same way they have done for the U.S. employment report, said Walter Todd, chief investment officer at Greenwood Capital in Greenwood, South Carolina.

"I fully anticipate that when this time rolls around next month, (investors) will obsess about it at that time," Todd said.

(Additional reporting by Herb Lash in New York; Editing by Alden Bentley and Nick Zieminski)